Archive for December 6th, 2007

As I finished writing this post over inflation concerns, Bank of England cut its benchmark rates by 25 bps. So now we have 3 developed countries cut rates- US, Canada and England. The press release of BoE says:

Although output in the United Kingdom has expanded at a brisk pace for the past two years, there are now signs that growth has begun to slow. Forward-looking surveys of households and businesses suggest spending is moderating, broadly in line with the projections contained in the November Inflation Report. But conditions in financial markets have deteriorated and a tightening in the supply of credit to households and businesses is in train, posing downside risks to the outlook for both output and inflation further ahead.

CPI inflation was 2.1% in October. Higher energy and food prices are expected to keep inflation above the target in the short term. Although upside risks to inflation remain, which the Committee will continue to monitor carefully, slowing demand growth should ease the pressures on supply capacity, bringing inflation back to target in the medium term.

This is a typical 2-handed economist message. Economists can sill talk using 2 hands, but an inflation targeting central bank should not. Why should BoE cut rates when risks from inflation remain?

Like this:

I had posted on the issue of rising food prices earlier as well. That time I had said they might rise now it is actually rising.

IMF’s chief Economist Simon Johnson sums up the entire development in his recent note. To see a snapshot of rising prices across commodities see this.

Why have prices risen?
1. Global growth particularly in emerging markets
2. Supply also rises with a lag
3. Serious droughts in some parts of the world
4. A focus on Bio-fuels means the land which was supposed to for wheat (just an example) is now being used for corn putting further supply pressures.

Impact
1. Developed world – not much as food as a % of consumption is low.
2. Exporters of agricultural products- would gain from rising prices. This includes both emerging and developed countries.
3. Emerging and poor countries- would impact as food as a % of total consumption is still quite high. This would lead to higher inflation.

Rising inflation would lead to tighter monetary policy (higher interest rates) in emerging markets. This would lead to widening interest rate differential and higher capital flows. So, problems of higher capital flows would continue. To this Johnson adds:

There’s nothing wrong with capital flowing from rich to poor countries—in fact, if it happens in the right form and with deliberate speed, it can definitely help development. But the IMF’s work on financial globalization emphasizes a very important health warning: if you get too much capital, too fast, and in too footloose a fashion, there can be serious consequences for your economic stability and growth.

Inflation is also going to rise in advanced countries as well. In developed countries, both direct and indirect impact of rising food prices on total inflation is low. (Indirect impact is when food prices effect other things like say wages. So if people start having higher food budget, they would demand higher wages and hence inflation would rise.) So inflationary concerns are low but remain.

Inflation is expected to rise and Central Banks in these countries are cutting rates (Canada and US). Testing times for Central Bankers.

In December edition of its quarterly magazine, Finance & Development, IMF has taken up issues related to future.

One essay deals with financial crisis of the future. It basically looks at answering the question – “Will they resemble the contagious crises of the 1990s or the country-specific crises of the 1890s?”

In 1890s financial globalization was much more than what we see today

The typical portfolio of a British investor around the turn of the 20th century was probably more internationally diversified, and included a far larger share of emerging market securities, than that of his great-grandchild living at the beginning of the 21st century

And globalization collapsed in the world war period and has only begun to pick up now. Earlier, the crises were limited to the country but now we see crisis hurting other economies as well (what we call a contagion). An exception was the Argentine crisis which only hurt Uruguay a bit.

IMF says in Argentina’s case most knew it is going to do badly and had already started withdrawing monies from it. Whereas with others it was a sudden stop and hence people withdrew money from other similar countries. Hence contagions could not be ruled out and perhaps would continue in future.

Moreover with increasing financial innovation and aggressive players (hedge funds, private equity etc) if a crisis takes place, contagions are more likely to happen. To manage them we would need coordination across countries and number of questions need to be addressed- Should these new entities be restricted? If not, should they be asked to disclose their portfolios?

Read the entire piece. It is full of fresh insights on what to expect.

In a related piece on global governance, IMF thinks we need to take a re-look at the 20th century model:

…what we have today is a multiplicity of independent actors, both public and private, each pursuing its own objectives and priorities, with its own clientele and constituency, with its own technical language and organizational culture, with its own mandate and specialized focus. These attributes may have been appropriate for a time when international relations focused on several important issues but just a small number of important countries. The lasting effect, however, is that we have inherited a system that is fragmented and that relies heavily, perhaps too heavily, on market forces, competition, and ad hoc public reactions to try to channel energies and allocate resources.

In the 21st century the challenges require more coordination than ever before:

The problems and the challenges of the 21st century—absorbing demographic change, reducing poverty, expanding the provision of safe and clean energy without aggravating climate change, alleviating health risks, and many others—require far more coordination than is possible within such a system. Each of these challenges, even if addressed locally or nationally, has the potential to affect the lives of people everywhere. Specialized technical expertise by itself is unlikely to be fully effective if it is not guided by a global and holistic vision.